Monday, February 17, 2014

Three Dividend Growth Stocks Defying Skeptics Expectations

Everyone likes the story of the underdog . This is the person who has everything going against them in life, yet they still prevailed. Every person can identify themselves as the underdog, because most everyone has been an underdog at some stage of his or her life.

The following three companies have managed to defy skeptics expectations, and prove them wrong, time and again. The companies are Digital Realty Trust (DLR), Dr Pepper Snapple (DPS) and PepsiCo (PEP).

Digital Realty Trust (DLR) recently increased its quarterly dividend by 6.40% to 83 cents/share. This REIT has raised distributions since going public in 2004. Back in May 2013, a short-seller hedge fund announced that Digital Realty would melt to $20/share. Hence they initiated a short position in the REIT, which has made a lot of investors very nervous. The hedge fund guy had several points about why the stock is going down, which I refuted point by point back in May. The other factor that scared investors in REIT in general was the threat of rising interest rates, which is supposed to obliterate the sector. In reality, even if treasury bonds yield 5%, investors would still be better off in high yielding REITs that can grow distributions over time. This is because those REITs will protect the purchasing power of income and principal against inflation. I have since added to my position in Digital Realty, and in one of those accounts I am automatically reinvesting distributions into more share ( this is something I rarely do). While I have no clue whether the stock price is going up or down from here, I am fairly confident that the dividend is going up over time.

It is likely that slowing dividend growth is probably worrying some investors. However, I have no problem holding a company with a safe 6% yield, which is growing above the rate of inflation. Check my analysis of Digital Realty Trust.

PepsiCo (PEP) was another company raising distributions in the past week. Despite decreased soda consumption in North America, the company has growth in snacks and in international sales. The company announced a 15 percent increase in its annualized dividend to $2.62 per share from $2.27 per share, to take effect with the June 2014 payment. The increase will be the 42nd consecutive annual increase in dividends per share for this dividend champion. It also anticipates increasing share repurchases in 2014 to approximately $5 billion. Check my analysis of PepsiCo.

The company expects to grow earnings per share by 7% in 2014, which is a healthy number. If a company sells at the same price to earnings multiple, and expands earnings per share by 7%/year and pays a 3% annual dividends, this can provide the investor with an annual total return of 10%. The only downside I can see with PepsiCo is if the P/E multiple contracts to say 15 times earnings, which would be an opportunity for investors like me in the accumulation phase of the game to buy more stock for the same amount of funds. As I have explained before, price fluctuations should mean nothing to long-term investors, except for as a tool to find bargains that were underpriced by the manic-depressive Mr Market. The upside for PepsiCo is earnings per share growth of at least 7%/year for the next 15 - 20 years. This could translate into earnings per share of almost $9 in 2024 and $18 in 2034. In reality, I could see that earnings per share growth can easily exceed that amount, given the exposure to growing emerging market economies, and a diversified products base.

The other upside for PepsiCo is if the snacks and beverages divisions are split-up, as some activist investors have recommended. This could unlock a lot of value for shareholders, as managements will be more focused on the core underlying segments, rather than two somewhat different businesses. In my experience, spin-offs are usually very beneficial to shareholders.

The other company I follow and own a small position in includes Dr Pepper Snapple (DPS). The compaby raised quarterly dividends by 7.90% to 41 cents/share. Dr Pepper Snapple was spun-off from Cadbury Schweppes in 2008, and has raised dividends since 2009. The company derives most of its profits from Carbonated Soft Drinks in the US, Canada and Mexico. This is not the rosiest of places to be heavily concentrated on, as volumes in North America have been decreasing for several years. However, the company has been able to cut costs, increase prices, repurchase stock and increase earnings per share even in this difficult environment. This is a quality company, which will be around 20 years from now, and will still be pumping out cold hard cash for shareholders. I could see how the company can easily grow earnings per share by 7%/year for the next 20 years, and pay a 3% yield, for an annual total returns of 10%. The company sells at 16 times earnings, which is cheaper than rivals Coca-Cola and PepsiCo. The one kicker is that every 20 years or so, Dr. Pepper could earn a couple billion dollars from its licensing agreements with PepsiCo and Coca-Cola, which are used for share buybacks and debt reductions. Plus, there is always the possibility that Dr. Pepper gets acquired by one of its larger rivals, which could result in better payoffs for shareholders.

However, I am actually more bullish on PepsiCo and Coca-Cola (KO), because they derive a large portion of revenues from outside the US. That being said, I still find Dr Pepper to be an impressive company. However, adding a third “soda” company to my portfolio is not really adding that much to it. Hence, I am keeping the amount invested below 1%. Check my analysis of Dr. Pepper.

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